INCOME STRATEGY – WHAT IS A ROTH CONVERSION?

A Roth conversion is the act of taking pre-tax funds from a traditional IRA, 403(b) or 401(k) account and electing to affirmatively convert these funds to after-tax funds in a Roth IRA, Roth 403(b) or Roth 401(k) account.

For example, suppose you have $10,000 of pre-tax funds in a traditional IRA. You may elect to convert these funds to after-tax dollars in a Roth IRA but, if you do, you must then pay taxes on the $10,000 that year. Therefore, a conversion is a taxable event for income tax purposes.

When you convert any portion of a tax-deferred traditional account, it is treated as accelerating the distributions on that account for the converted portion and accordingly, the income tax on those distributions is also accelerated to the year of conversion. You will have to pay income tax on the converted assets in the year of conversion (except to the extent the distribution represents a return of any non-deductible contributions). The tax will be paid at your applicable income tax rate that year.

Prior to 2010, there was a restriction that prevented many higher-income individuals and couples from converting funds to a Roth account. Beginning in 2010, this income limitation was removed, so anyone can convert funds to a Roth account.

Tax Advantages

A Roth conversion strategy makes sense if you can pay taxes today (or early) at a lower tax rate versus withdrawing the same money in a tax deferred account later at a higher tax rate. So, the goal is to keep more of what you have accumulated by paying less tax. It may be smart for you to do a Roth Conversation if you will pay taxes at a higher rate in the future. However, if you will be in a lower tax rate in the future, it probably will not make sense for you to do a Roth Conversion.

How to Do a Roth Conversion

It’s not always simple to complete a Roth conversion. Most major brokerage firms can help you convert to a Roth IRA. The simplest way is a direct trustee-to-trustee transfer from one financial institution to another. If you’re going to keep your money with the same institution, you can tell them n to re-designate your traditional IRA as a Roth IRA.

If you are converting assets from a traditional 401k or other employer-sponsored plan to a Roth IRA, make sure the transfer is directly to the financial institution. If your company issues the check to you, it will be subject to a 20 percent penalty for tax purposes. You’ll have only 60 days to deposit all the money in a new Roth account—including the 20% that was withheld. If you miss the 60 day deadline, the money will be subject to a 10 percent early withdrawal penalty if you are younger than 59 ½–on top of the income taxes will owe on the converted amount.

Let Us Help

Our full service registered investment advisory firm is available to help with your Roth conversion. For a nominal fee, we can complete the process on your behalf so you don’t miss any of the details.

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